Case Analysis: Salomon v A Salomon & Co Ltd

Authors

Adwitia Maity, Department of Law, University of Calcutta

Shivangi Mugdha, NMIMS Kirit P Mehta School of Law Mumbai

Shashwat Raj, Asian Law College

Editor : Sheetal Sharma, Faculty of Law, University of Delhi


Case: Salomon v A Salomon & Co Ltd

Date of Judgement: 16 November, 1897

Court: House of Lords

Citation- [1897] AC 22

Whenever a company is incorporated it has its own legal personality and independent status. Salomon v. Salomon is the leading case of Company law which helps us to understand and develop the concept of corporate personality i.e. separate legal entity.

Facts- A businessman named Aron Salomon, specialized in manufacturing of leather boots or shoes, runs his business as a sole proprietorship firm. His son wanted to join his business so, Aron Salomon incorporated a company naming Salomon and Co Ltd which acquired his proprietorship firm business with a consideration of £ 38000.

Company's position in terms of shareholding and members

Total share capital of company was 40,000 shares; each share value costs £1 each.

The memorandum of this company consists of 7 members

1) Aron Salomon- holds 20,000 equity shares

2) Wife- holds 1 share

3) Daughter- holds 1 share

4) 4 sons- holds 1 share each

Directors

Aron Salomon and his two elder sons were the directors of the company. Aron Salomon acquires 1% of the company by holding 20,000 shares.

Creditor

Salomon is also creditor of the company, who gave £10,000 to his company in the form of debentures (loan). On the basis of his prior debenture security, Salomon received £5000 in advance from Edmund Broderip.

Liquidation process of Salomon's company

When his business was in proprietorship form it was completely solvent, but after 1 year when the company underwent financial difficulties, it had only £6000 assets and £16000 liabilities and the division was £10000 to Salomon and £6000 to unsecured creditor.

As Salomon’s business kept declining, then began the default on interest payment of debentures (half held by Broderip). Therefore, Broderip and unsecured creditor both sued Salomon to retain their money back, which resulted in liquidation of Salomon and Co Ltd. Salomon returned £5000 of Edmund Broderip, but claimed remaining £1000 of company assets as his retained debentures, thus making the matter dispute with unsecured creditor.

Issue of the case- The issue of the case mainly revolved around the fact that whether or not the amount that was paid to Mr. Salomon is to be paid back to the company so that it can be distributed among the unsecured creditors. The liquidator argued the formation of the company as fraud and claimed that Salomon breached his fiduciary duty.

Judgement- Given that, at the time, the company was indebted to unsecured creditors; an action against the appellant was brought by the company’s liquidator and the case tried before Vaughan Williams, J. of the High Court. Vaughan Williams J declared Broderip’s claim to be valid arguing that the signatories were just but mere dummies which Mr. Salomon was acting as an agent of the corporate. Thus, the corporate was entitled to indemnity from the principal who during this case was Mr. Salomon.

The ruling made by the Court of Appeal further confirmed the earlier decision made by Vaughan William, J. The Court of Appeal ruled that Broderip’s claim was valid on grounds that the Appellant had abused the privileges of incorporation. Consistent with the Court of Appeal, the incorporation of the corporate was improper because the Act only contemplated the incorporation of independent real shareholders with the desire and minds of their own and not mere puppets. The Court of Appeal, stating the company to be a myth, reasoned that Salomon had incorporated the company conflicting to the true intent of the then Companies Act, 1862, and that the latter had showed the business as an agent of Salomon, who should, therefore, be accountable for the debt incurred in the course of such agency.

This decision was, however, unanimously overturned by the House of Lords and therefore the arguments of fraud and agency rejected. They held that the Act had to be the only guide for deciding whether a company had been validly constituted. Consistent with the companies Act 1862, just a share was enough for one to be named as a member. It had been therefore not so as to label shareholders as dummies or mere puppets since the corporate had been duly constituted by law and thus had a separate legal entity (Macintyre 2012).

The House of Lords held that the presence of a company is quite independent and separate from its members and that the resources of the company must be used in payment of the debentures first in priority to secured creditors.

Lord Halsbury said “Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr. Salomon… If it was not, there was no person and no thing to be an agent at all; and it is impossible to say at the same time that there is a company and there is not[1]”.

He also held that “It has become the fashion to call companies of this class “one-man companies.” …If [this] is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading: if it merely means that there is a predominant partner possessing an overwhelming influence and entitled practically to the whole of the profits, there is nothing in that that I can see contrary to the true intention of the Act of 1862, or against public policy, or detrimental to the interests of creditors. If the shares are fully paid up, it cannot matter whether they are in the hands of one or many. …It was argued that the agreement for the transfer of the business to the company ought to be set aside, because there was no independent board of directors, and the property was transferred at an overvalue. There are …two answers to that argument. In the first place, the directors did just what they were authorized to do by the memorandum of association. There was no fraud or misrepresentation, and there was nobody deceived. In the second place, the company have put it out of their power to restore the property which was transferred to them. It was said that the assets were sold by an order made in the presence of Mr. Salomon, though not with his consent, which declared that the sale was to be without prejudice to the rights claimed by the company by their counter-claim. I cannot see what difference that makes[2]”.

The House of Lords remarked that it had been improper for the judges to read into the statute limitations relying upon their personal opinion. The House further noted that while the company persisted precisely an equivalent even after being incorporated with an equivalent hand receiving profits; by law, the company wasn't an agent nor a trustee of the subscribers and therefore the subscribers were also not responsible for any of the company’s liabilities.

Since then, legislatures and courts have followed the separate entity principle. This principle which is enshrined in article 16 of the Companies Act 1997 have since been followed in company proceedings in court. Salomon’s case has become a landmark company case law within the UK and is usually cited in most cases within the world of company law.

[1] Aron Salomon vs A. Salomon and Comp. [1876] AC 22 [2] Supra

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